Real and nominal rates interest Zane Perelli currently has$108 that he can spend
ID: 2817901 • Letter: R
Question
Real and nominal rates interest Zane Perelli currently has$108 that he can spend today on polo shirts costing $ 27 each. Alternatively, he could invest the $108 in a risk-free U.S. Treasury security that is expected to earn a11 % nominal rate of interest. The consensus forecast of leading economists is a 4 % rate of inflation over the coming year.
a. How many polo shirts can Zane purchase today?
b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today? (Ignore taxes.)
c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation?
d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy at the end of 1 year?
e. What is Zane's real rate of return over the year? How is it related to the percentage change in Zane's buying power found in part d ? Explain.
Explanation / Answer
As per rules I will answer the first 4 subparts of the question
1: Number of tshirts that Zane can purchase= Amount/Price
=108/27 = 4
2: Amount of money at the end of 1 year = P*(1+r)^n
= 108*1.11^1 = $119.88
3:Price of the shirt after 1 year = Price*(1+Inflation rate)
= 27*1.04 = 28.08
4: Number of shirts that Zane can purchase at the end of 1 year= 119.88/28.08
= 4.27 shirts
Zane can purchase (4.27-4)/4 * 100
= 6.75% more shirts
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